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The ECB needs to convert its bonds so that they can be addressed separately. So far, there is no indication on Bloomberg, which gets its bond information from trustees, that this has been done. The outstanding amounts of existing GGB and Greece (Greek and English law bonds) hasn’t changed.

Greece has to implement a retroactive collective action law. With some luck, they will implement that, before the ECB actually converts their bonds.

As we’ve written before, both of those actions are likely to be challenged. Possibly without success, but delaying the deal past March 20th is really the key if you hold short dated bonds. I think if you hold English Law bonds, the challenges have more likelihood of success, and more importantly, getting you a recovery.

In the meantime, by March 9th, the participation rate for each bond will be known by the authorities, and for argument’s sake, assume that the ECB’s swap has been upheld, and the CAC clauses are deemed valid.

Then the Troika and Greece will have to decide what to do.

If all tranches get 100% participation through this process, I would be shocked, but then it is easy for the Troika and Greece, and there wouldn’t even be a CDS Credit Event.

Since I can’t believe there will be 100% agreement on each and every bond, it gets a lot messier, in a hurry. The first thing they should be looking at is the participation rate of the March 20th, 2012 bonds. This is money that is going out the door immediately.

What do you do if these get a 90% agreement rate on the March 20th bonds? Or, alternatively, €1.5 billion of holdouts in those bonds. Do you pay the holdouts €1.5 billion? That is a cost to the Troika and Greece of €750 million versus executing the CAC. That money will be going to banks or more likely, hedge funds. That €750 million is 2 years worth of the additional budget cuts that got pushed through this weekend. They can decide to not pay other bonds as they come due. On the other hand, using the CAC will cause a Credit Event. Are they prepared to have a CDS Credit Event? I think they should have done this a long time ago, and had a Credit Event, so maybe they finally agree, and will be happy to trigger CDS. They might even be looking to trigger the CDS to help any banks that actually bought it, and held onto it.

So this is the key on the March 20th bonds. How much is the Quoika (I was sick of writing the Troika and Greece) be willing to pay to holdouts in order to avoid causing a Credit Event today? The holdouts are likely to be mostly at the front end as they are more likely to see the Quoika flinch and accept paying money in the near term to avoid triggering CDS. At the very long end, you give up coupon by agreeing to the PSI deal, but taking the deal seems less bad as you get some of your money in EFSF bonds (closer to cash) and some long dated bonds that are just as unlikely to get paid off as the ones you currently own. If you bought the longer dated bonds recently, the deal doesn’t seem bad.

Which is more important, the average acceptance rate, or the acceptance rate of any one bond. Will they be happy to let the holdouts exist over time? For anything other than the March bonds, they can always try to get them to change their mind over time. It is only the March bonds that cause the real dilemma. It comes down to paying the holdouts vs triggering a Credit Event. They still seem scared of creating a Credit Event, but paying out par to banks who didn’t participate or to hedge funds (evil speculators) at a time where they are putting the boot to Greece for every possible Euro of savings cannot look good either.

Is there a number on the front end bonds, where no matter the participation rate on the other bonds, where they just can’t stomach the payment and choose to use the CACS and create a Credit Event?

We still need to see the exact PSI details. For now I’m working under the assumption that both the EFSF bonds used to pay for accrued interest and for 15% of notional will have a coupon so that they can be worth nearly par. I’m using the coupon and amortization schedule that has been provided. I’m assuming the €205 billion or so of bonds subject to PSI are each being offered the same deal and no preference is being given for maturity or coupon.

Under those assumptions (which we should find out more tomorrow when PSI comes out), I like buying the March bonds which may be as cheap as 34 now and adding also buying some of the lowest dollar price longer dated bonds – hearing some offered as cheap as 22.

The view is that if you buy the short dated bonds at 34 and holdout, there is a chance, that you get paid out at 100 (or some revised deal that offers you something below par, but far better than existing PSI).

If you hold out on the bonds, you will either get paid at par (agree to some new deal) or get CAC’d. I cannot see Greece failing to pay the bonds. While a CAC causes a Credit Event, failing to pay, also causes a Credit Event and makes for a far less controlled situation (and the EU would have to stop pretending that Greece hasn’t defaulted).

If you get paid out it is great on the short dated bonds, but if you get CAC’d, you can assume that the exchange rate will be close to 100% (once the Quoika has CAC’d one bond, I don’t see why they would be reluctant to CAC other bonds). So if you don’t get paid, the outcome is likely that 100% of the non ECB bonds get exchanged.

This should provide the highest valuation for the post PSI bonds. The greatest reduction in principal possible will have occurred. With over €100 billion Euro of debt wiped out, where should these bonds trade?

Portuguese 10 year bonds are around 15% while the long bonds are yielding 15%. These new Greek bonds will be subordinated to the Troika loans and bonds, but will the improvement in GDP be enough to let them trade at a 15% yield. At a 15% yield on the new bonds, the package is worth just over 23 points, ignoring the GDP kicker. If the value of 23 is correct, then you make 1 point on your long bonds and lose 11 points on your short dated bonds. If the new bonds trade as good as 12% (still worse than Portuguese long bonds), then the package is worth about 26 points, and trade is up 4 points on one bond, down 8 on the other. I don’t think that is an unreasonable assumption, though the new bonds should be incredibly volatile for a bit as they change hands, but they might be eligible collateral for LTRO3. If they pay out the March bonds the new Greek bonds could be worthless making that package worth only about 17 points, but the 5 point loss is nothing compared to the 66 point gain.

What could go wrong with this trade? The yield on the new bonds could be 20% making the package only worth 20.5 points (remember, about 15 is coming from the EFSF so you are only relying on Greek bonds for a portion of the value). That would be bad, and maybe that is most likely scenario, though I think if the CAC the March bonds forcing you into the package, that should help post PSI Greek yields.

The other concern, is that PSI is such a mess, or that Greece continues to erode, or some governments fail to support the deal, and it gets cancelled and Greece actually doesn’t pay any of its bonds. Recoveries (or at least near term trading prices would be lower than the PSI package values) making the trade far worse. Somehow no one in equity land or fx land seems to believe a failure to pay can occur, but I think bond values here, show that the credit markets are far less convinced that the can has been kicked.